Earnings Call Transcript - MCB Q1 2022

Operator, Operator

Welcome to Metropolitan Commercial Bank First Quarter 2022 Earnings Call. Hosting the call today from Metropolitan Commercial Bank are Mark DeFazio, President and Chief Executive Officer; and Greg Sigrist, Executive Vice President and Chief Financial Officer. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the prepared remarks. During today’s presentation, reference will be made to the company’s earnings release and investor presentation, copies of which are available at MCBankNY.com. Today’s presentation may include forward-looking statements that are subject to certain risks and uncertainties that may cause actual results to differ materially. Please refer to the company’s notices regarding forward-looking statements and non-GAAP measures that appear in the earnings release. It is now my pleasure to turn the floor over to Mark DeFazio, President and Chief Executive Officer. You may begin.

Mark DeFazio, President and CEO

Thank you, Brittany. Good morning everyone and welcome to MCB’s first quarter earnings call. Greg and I will provide some brief updates and then we hope to have an engaging Q&A session. Although MCB started 2022 on solid ground and believed we were nearing the end of COVID, we were unexpectedly confronted with the Omicron variant, geopolitical instability due to the war in Ukraine, federal tightening, and unprecedented inflation levels. For those unprepared for these challenges, the consequences could be severe. Over the past two decades, what stands out the most is MCB's consistent ability to be ready for each disruptive event we've faced. MCB's resilience during these times not only safeguarded its balance sheet but also allowed for growth, enhancing profitability and shareholder value. What I find particularly noteworthy this quarter, as we navigate the previously mentioned challenges, is the strategic importance of this period for MCB and its clients, as we deployed excess liquidity. Our longstanding focus on the liability side of our balance sheet continues to yield rewards. The robust and scalable low-cost deposit components of our business model enable us to manage our margins effectively and invest excess liquidity into higher-earning assets. Our business strategy mirrors that of our clients, who aim to leverage their equity and liquidity to generate targeted returns for their shareholders. Now, I would like to share a few highlights from our liquidity initiatives. During the quarter, MCB invested $390 million in loans, maintained a target of 15% of assets in investments, and redeemed $25 million of subordinated debt at a rate of 0.625% on March 15th, eliminating pressure on our net interest margin and net interest income going forward. In terms of client highlights, a global crypto exchange client made an acquisition for $260 million in cash, from which MCB is already reaping benefits as we integrate with that company, expecting operations to commence with MCB's support this quarter. Clients in the healthcare sector completed $322 million in acquisitions of skilled nursing homes and assisted living facilities, with MCB working to integrate these facilities and establish deposit relationships that will significantly bolster our low-cost deposit base. In commercial real estate and retail, we experienced approximately $50 million in outflows due to strategic acquisitions, debt reduction, and normal operational investments. As a Commercial Bank, MCB's clients are actively focused on creating generational wealth. MCB's core mission has always been to support clients in building and maintaining this wealth, fostering lasting business relationships. Additionally, MCB saw new deposit inflows of $190 million, primarily from the Commercial Bank, of which $100 million was non-interest-bearing and $90 million was interest-bearing. Turning to some general highlights for the franchise: total revenues increased by 39%; non-interest expenses rose by 21%; and our efficiency ratio fell to 45.6% from 52.1%, reflecting our long-term strategy to leverage investments for rapid positive operational leverage. Total loans grew by $884 million, or 27%; total deposits increased by $1.5 billion, or 34%, including BBAs, which rose by $1 billion, or 47%. For our Global Payments Group, revenues surged by 68% compared to the first quarter of 2021. Transaction volumes in the first quarter of 2022 reached 28.5 million, marking a 74% increase from the same period in 2021, while dollar volume transactions climbed by 147% to just over $8 billion. We are focused on enhancing what we consider to be the best-in-class consumer compliance foundation for our banking-as-a-service operations, which is driving more partnerships with high-quality fintech firms. I am also pleased to report that our return on average tangible common equity for the first quarter was 14%, which is impressive, especially considering this is just the second quarter following our successful $175 million capital raise in September 2021. Before handing it over to Greg, I want to mention, as I noted last quarter, that we had some expansion initiatives. Since signing our lease in Florida for a loan production office, I’m happy to share that retail deposits have risen by $10 million; commercial real estate loans closed totaled $14 million. We have a loan pipeline of approximately $38 million, and C&I loans closed amounted to $231 million in Florida. Now I’ll pass it to Greg.

Greg Sigrist, Executive Vice President and CFO

Thank you, Mark. The momentum has certainly carried over into the first quarter of 2022 with net income of $19.02 million or $1.69 of fully diluted earnings per share. Let me take you through a few of the key drivers this quarter. We had a remarkable start to the year for lending. Loan originations were $490 million in the quarter, up 19% from a strong fourth quarter and 107% from a year ago. Volumes are strong across our verticals, particularly so for CRE Skilled Nursing. Net loan growth was $390 million or 10.4% in the quarter. The pipeline does remain robust across all verticals, and credit quality is very strong. As a reminder, there was one non-accrual CRE loan of approximately $9.9 million that paid off in full in January. That leaves non-performing loans at a nominal level. With no charge-offs effectively zero, the credit provision was driven by the strength of our loan production in the quarter. Mark’s already touched on the impact that strategic investments being made by our clients had on deposit flows in the quarter. I will just note though that GPG-related deposits, which were elevated at year-end, did come down later in the quarter given those strategic moves. However, average GPG deposits were up 15% from the fourth quarter. Our deposit base remains a well-diversified mix of core deposits. The total cost of deposits declined 2 basis points in the quarter to 23 basis points, with selective repricing of certain deposits earlier in the quarter. Total cost of funds remained steady at 28 basis points, but that does include the impact of deferred issuance costs recognized when we redeemed the subordinated debt. Importantly, our liquidity position remains strong, with overnight deposits at 21% of total assets. Net interest margin in the quarter did increase 12 basis points to 2.71%, due in large part to the deployment of liquidity into loans and securities. As you would have seen in our investor deck, 45% of the loan portfolio is floating rate, and of that, 75% are subject to floors; 60% of the loans subject, of course, will lift off by the time the rates are up 100 basis points, with the remainder lifting off ratably by the time rates are up an additional 100 to 200 basis points. With our loan growth, liquidity position, and asset sensitivity, our balance sheet is very well positioned to benefit from rising rates and drive long-term shareholder value. Non-interest income was up 5.2% in the quarter on the strength of banking-as-a-service revenues from our Global Payments business, which were up 6.9%. Expenses were well managed in the quarter. As expected, we did see seasonal impacts from employer taxes and benefits. As we’ve mentioned in the past, we do expect to continue making investments, particularly in human capital, and remain quite focused on maintaining positive operating leverage as we do so. Our effective tax rate of 27% in the quarter included one-time tax benefits totaling $1.2 million, including the impact of vesting date fair values of employee stock-based compensation, which were significantly higher than grant date fair values. We would expect the effective tax rate for the full year, excluding the impact of discrete items, to be in the range of 31% to 32%. Our capital levels remain very strong, with all capital ratios significantly above well-capitalized levels. Our Tier 1 leverage ratio was 8.6% at March 31st. Overall, the year is off to a great start reflecting the sustained growth and performance across our businesses. And I’ll now turn the call back to our Operator for Q&A.

Operator, Operator

Thank you. We will take our first question from Chris O’Connell with KBW. Your line is now open.

Chris O’Connell, Analyst

Good morning, gentlemen. Nice quarter. I just wanted to start off with similar deposit flows that you guys mentioned regarding the client acquisition and now onboarding that new client in the second quarter. Is that going to impact or recapture some of the deposits lost this quarter immediately or is that going to be more of a ramp-up over time?

Mark DeFazio, President and CEO

I would say, in that specific case, Chris, and good morning, it would be over time. We’re integrating with that acquired company. The company will go live. It’s a new exchange for cryptocurrency. So, we expect to see deposit flows coming back, and of course, fee income as well coming into the bank over the next three quarters.

Chris O’Connell, Analyst

Understood. And so on the GPG fees related to that, should we expect any pullback next quarter from the loss of the deposits coming over the course of the first quarter or is it kind of still a pretty good trajectory from the 1Q run rate levels?

Greg Sigrist, Executive Vice President and CFO

If I understand correctly, when you mention pullback, you're referring to clients using their liquidity for strategic reasons, such as acquisitions or technology development. This won't have an immediate effect on revenue. Therefore, GPG should continue to generate revenue as we anticipate, since its core business is strong and all clients are performing well and expanding their operations. The use of liquidity does not directly impact current revenue, if that's your question.

Chris O’Connell, Analyst

Okay. Got it. And then on the loan growth this quarter, I mean, really strong and can you talk a little bit about the Florida C&I deposit growth, some particularly strong interest, some of the other drivers and business change or loan growth outlook for the year, given a strong start to the first quarter or do you expect a little bit more moderation in the coming quarters?

Mark DeFazio, President and CEO

We’re working backwards there. Looking at our current pipeline, I can’t suggest that it’s going to level off. We’re out there working. We’re in different markets. So I would expect to have robust loan originations and strong asset quality for the rest of the year.

Greg Sigrist, Executive Vice President and CFO

Yeah. The only thing I would add, I mean, at some point you’re going to see some payoffs happen. I agree with Mark, and I think the pipeline is really robust. I think I wouldn’t keep the first quarter trajectory in place for the balance of the year. I think over the balance of the year, there will be some moderation, but it’s still going to be a very strong growth year for us.

Chris O’Connell, Analyst

Got it. Understood. Regarding the cash situation, it appears that a significant amount of loans were funded or cash was pulled down quite late in the quarter, considering the average balance. Can you discuss the net interest margin, which may be challenging to project in the long term, particularly in relation to the subordinated debt redemption and the late-quarter cash pull down? What are you anticipating for the net interest margin in the second quarter?

Mark DeFazio, President and CEO

Yeah. Chris, as you know, we don’t give guidance on the net interest margin itself. But you hit on a couple of the key drivers, obviously repaying the subordinated debt takes away a bit of a drag, which is really helpful. Converting the liquidity in the first quarter into loans, obviously, we’re not going to see the full benefit of that until the second quarter. So as we continue to really deploy on the loan side, you’re going to expect to see some pretty healthy expansion on the net interest margin just on the loan side. I think the big driver over the balance of the year, and maybe it’s the question mark, is the rate environment. We do have a pretty healthy part of the loan portfolio that is floating, so you’re going to see some uplift from that as well. And obviously, over time, you’re going to have repricings in both these securities portfolio and the loan portfolio. So, I mean, I think, you’re going to see margin expansion from here and you should be able to with the input you’ve got to kind of model that out.

Chris O’Connell, Analyst

All right. Got it. I’ll step out for now. Thanks.

Greg Sigrist, Executive Vice President and CFO

Yeah.

Mark DeFazio, President and CEO

Thanks, Chris.

Operator, Operator

Thanks. We’ll take our next question from Alex Lau with JP Morgan. Your line is now open.

Alex Lau, Analyst

Hey. Good morning.

Mark DeFazio, President and CEO

Good morning.

Greg Sigrist, Executive Vice President and CFO

Hi.

Mark DeFazio, President and CEO

Good morning, Alex.

Alex Lau, Analyst

Can you expand on what drove the very strong loan originations in the quarter? In the press release, you touched on clients getting more active in business investments and acquisitions. Is this a 1Q thing or do you think this will continue throughout the year?

Mark DeFazio, President and CEO

I think it’s going to continue throughout the year. This was really a very interesting quarter. I sort of touched on everything that’s going on around us as well. So it was a bit surreal in a sense of how active our clients were not only here in the New York area, but in other markets as well. Our lending teams and all professionals that are running these lending teams are just the best-in-class, and we are just very busy. We’re out there, we’re very engaged; we are hopping all over the cities. We’re not working out of New York; we’re not working out of Laholm. We are actually on site, looking at acquisitions, looking at strategic initiatives our clients are looking at. I have to tell you, I just think it’s our effort alongside the strategic nature of the client base that we have. Remember, we are a Commercial Bank. So our clients are very active. They’re here to build and sustain generational wealth, and we just step up for it. We’re aligned, all professionals aligned 24/7 with helping them achieve that.

Alex Lau, Analyst

Thanks for that. When you look at the deposit growth for the year, which deposit vertical are you most optimistic on driving growth?

Mark DeFazio, President and CEO

I try not to think of it that way. GPG could explode, because of just the sheer scale and conversion rate of our fintech partners. So I’m excited and optimistic, I guess you could say about the possibilities of GPG, just because of the nature of those clients. But on the other hand, our healthcare practice and our Commercial Lending Group and our General Corporate Finance or Commercial Lending Group are really stepping up, and our retail teams are really doing well. As you saw, we brought in $190 million of core deposits, not including basically GPG this quarter. So I’m optimistic about all the verticals.

Greg Sigrist, Executive Vice President and CFO

Yeah. I think that really just shows the strength of our deposit franchise and the verticals, and yeah, I agree with Mark.

Alex Lau, Analyst

Thanks for that. On deposits betas, so what are your expectations for deposit betas for the year, and how does that compare to the last rising rate cycle?

Mark DeFazio, President and CEO

I believe we will be quite careful regarding deposit betas. As a Commercial Bank, our role is to provide working capital for businesses. This reduces the pressure to significantly raise rates, as the funds flowing in and out are related to their operational cash needs. In the previous cycle, which was quite a while ago, we navigated a higher rate environment with diligence. We do not anticipate a substantial increase in our costs and liabilities due to rising rates. It's important to note that we are well-prepared and continuing to prepare for a declining environment, as our lenders are adjusting their thresholds upward. My current focus is on ensuring that we are raising our thresholds as loan yields increase, rather than worrying about the rising costs of funds.

Alex Lau, Analyst

Thank you. On slide 13, it shows how client transaction volumes have increased from a year ago, but down quarter-over-quarter. Can you give some color on what is driving this?

Greg Sigrist, Executive Vice President and CFO

I think it's important to note that we started the year dealing with the Omicron variant, which has influenced a lot of travel-related transactions. Additionally, we need to consider the geopolitical and inflationary factors that Mark mentioned. Besides these general macro drivers, there isn't anything particularly special happening. However, we are still experiencing strong revenues, and it's important to recognize that the mix plays a role; it's not solely about the quick fees. There are other underlying factors at work. Our primary focus is on the long-term trajectory, as that will ultimately validate our fintech strategy.

Alex Lau, Analyst

Thanks. And last one for me on securities to total assets, your 15% target, are you maintaining this target for the rest of the year?

Greg Sigrist, Executive Vice President and CFO

Yeah. Absolutely intending to, Alex.

Alex Lau, Analyst

Thanks, guys. That’s it from me.

Mark DeFazio, President and CEO

Yeah. You are welcome.

Operator, Operator

And we have a follow-up with KBW. Your line is now open.

Chris O’Connell, Analyst

Hi. Just want to follow-up on some of the deposit beta discussion. Can you just remind us of the dynamics around, and unfortunately, deposits are tied to short-term rates and the balance of those deposits? And can you just remind us the dynamics of how that flows through on the expense side of the income statement versus interest expense?

Mark DeFazio, President and CEO

Well, I think the majority of our interest rate exposure, obviously, flows through interest expense. I think if I’m understanding your question right, Chris, in terms of how it flows through as rates rise, there’s a very small component of our licensing fee expense that is tied to rising rates. But I think, as you probably recall, there is a $300 million notional derivative that’s in place on that. So you’re going to see licensing fees subject to one month LIBOR up to the cap rate on that derivative, which is 125 basis points, but only up to that point.

Chris O’Connell, Analyst

Okay. Great. So shouldn’t see at least in the immediate next couple of quarters a large component in the licensing fee like on.

Greg Sigrist, Executive Vice President and CFO

No. You’ll see it, again, you have to assume the Fed's going to raise 50 basis points in May and another 50 in June. If you follow that market logic that, you’re going to see any of that pull-through effect in the second quarter, and then after that the cash is going to kick in.

Chris O’Connell, Analyst

Okay. Got it. Thanks for the color. Appreciate it.

Mark DeFazio, President and CEO

You are welcome.

Operator, Operator

And we will take a follow-up from Alex Lau with JP Morgan. Your line is now open.

Alex Lau, Analyst

No other questions from me, guys.

Operator, Operator

And do we have any follow ups from Chris O’Connell with KBW.

Chris O’Connell, Analyst

I am all set. Thank you.

Operator, Operator

This concludes the allotted time for questions. I would now like to turn the call back over to Mark DeFazio for additional or closing remarks.

Mark DeFazio, President and CEO

Thank you. I just want to say thank you again for your support and interest in MCB. I look forward to speaking with any of you during the quarter and look forward to our next earnings release. Thank you very much and have a nice weekend.

Operator, Operator

This does conclude today’s conference call and webcast. A webcast archive of this call can be found at www.MCBankNY.com. Please disconnect your line at this time and have a wonderful day.